Saturday, 15 August 2009

Nominal APR and Effective APR (EAR)

These are about how much interest you have to pay when you get a loan or overdraft:

http://en.wikipedia.org/wiki/Annual_percentage_rate

AER is a compounded interest and that's the real interest that you finally pay.

Example:
For example, imagine you have a Current Plus account from NatWest and you are allowed to have an overdraft of up to £2000. You use £1000 of your overdraft on 1/1/2009. If you don't pay anything back monthly because the AER is %19.24, according to this site, after 1 year what you have to pay back is 1,192.4 (base + base * 19.24 / 100). This amount is your new base and any further payment is calculated based on that so

If you don't pay back anything after 2 years your debt is:

1,192.4 + 1,192.4 * 19.24 / 100 = 1,421.82

After 3 years your debt is:

1,421.82 + 1,421.82 * 19.24 / 100 = 1,695.38

After 4 years your debt is:

1,695.38 + 1,695.38 * 19.24 / 100 = 2021.57

As you can see after 4 years time, your debt has been doubled. Also you have exceeded your overdraft limit, so you will be charged for that too and the debt can easy reach to a higher amount.

So, be careful of your debts and know well how they are calculated.

Bank's Profit:
On the other hand, if you have saved £1000 in your NatWest bank account and haven't touched it for 1 year, the net interest bank pays you is %0.08, according to this site, which means after 1 year you will have £1000.80.

As you can see for a £1000, Bank sells it for £194.20 a year whereas it buys it for only 80 pence; So much profit!

If you see it for longer periods the profits will be much larger.

When Government lowers the interest rate, one immediate consequence of that is that they want to help the banks make more profits essentially.